Fed ties rates to jobs recovery

‘OPERATION TWIST’:The US central bank also replaced an expiring stimulus program with a commitment to purchase US$45 billion in longer-term Treasuries each month

Reuters, WASHINGTON

The US Federal Reserve, announcing a new round of monetary stimulus, took the unprecedented step on Wednesday of indicating interest rates would remain near zero until unemployment falls to at least 6.5 percent.

It was the latest in a series of unorthodox measures taken by central banks around the world to battle erratic, sub-par recoveries from the financial crisis and recession of 2007 to 2009.

The Fed expects to hold rates steady until its new threshold on unemployment was reached as long as inflation does not threaten to break above 2.5 percent and inflation expectations are contained. It also replaced an expiring stimulus program with a fresh round of Treasury debt purchases.

The central bank previously said it expected to hold rates near zero through at least the middle of 2015, but policymakers were uncomfortable making a pledge based on the calendar rather than the economic goals they hope to achieve.

“By tying future monetary policy more explicitly to economic conditions, this formulation of our policy guidance should ... make monetary policy more transparent and predictable to the public,” Fed Chairman Ben Bernanke told a news conference.

Importantly, in the eyes of Fed officials, the new framework should help financial markets assess incoming data in a way that helps them better guess were monetary policy is heading.

Right now, the Fed is engaged in an open-ended program of asset purchases, which it bolstered on Wednesday.

Officials committed to buy US$45 billion in longer-term Treasuries each month on top of the US$40 billion per month in mortgage-backed bonds they started purchasing in September. They repeated a pledge to keep pumping money into the economy until the outlook for the labor market improves “substantially.”

The Fed will fund the new Treasury purchases with an expansion of its US$2.8 trillion balance sheet. Under the expiring “Operation Twist” program, the Fed bought an identical amount, but paid for them with proceeds from sales and redemptions of short-term debt.

Some policymakers view actions that expand the Fed’s balance sheet as economically more potent than actions that do not. However, Bernanke said the dose of stimulus would remain about the same, given that the central bank is still purchasing a combined US$85 billion per month in longer-term securities.

“They see an anemic economy, and they’re doing all they can to get any economic progress,” said Alan Lancz, president of Alan B. Lancz & Associates in Toledo, Ohio.

The Fed’s decision initially gave a small lift to US stock prices, but the major indexes closed mostly unchanged, while government bond prices fell. Oil prices rose and the US dollar weakened against the euro.

Fed policymakers voted 11-1 to back the new plan. Richmond Federal Reserve Bank president Jeffrey Lacker dissented, as he has at every meeting this year, expressing opposition both to the bond buying and the new economic thresholds. The newly unveiled numerical policy guidelines offered the most specific suggestion yet that the Fed is willing to tolerate slightly higher inflation, as it tries to juice up a moribund economy and spur stronger job growth.